利安德巴塞爾 (LYB) 2006 Q3 法說會逐字稿

Hello, and welcome to the Lyondell Chemical third quarter 2006 earnings teleconference. At the request of Lyondell Chemical, this conference is being recorded for instant replay purposes. Following today's presentation, we will conduct a question-and-answer session. [OPERATOR INSTRUCTIONS]

I'd now like the turn the conference over to Doug Pike, Vice President of Investor Relations. Sir, you may begin.

Thank you, and good morning. I'm joined today by Dan Smith, our President and Chief Executive Officer; Morris Gelb, our Chief Operating Officer; and Kevin DeNicola, our Chief Financial Officer. And today the agenda for the call will be as follows; I'll review our third quarter performance, Kevin will summarize financing activity, and then Dan will discuss the refinery transaction and the inorganic strategic considerations, and then we'll open the call up to your questions. Our call today is scheduled to last 60 minutes.

But before we begin, I'd like for you to note that statements made in this teleconference relating to matters that are not historical facts are forward-looking statements that are subject to risks and uncertainties. Actual risks could differ materially from those forward-looking statements and for more detailed information about the factors that could cause our actual results to differ materially, please refer to our earnings release issued this morning and please also refer to Lyondell's, Equistar's and Millennium's annual reports on form 10-K for the year ended December 31, 2005 and quarterly reports on form 10-Q for the quarter ended September 30, 2006, which will be filed with the SEC in November of 2006, as well as Lyondell's form 8-K filed on September 7, 2006.

I'd also like to point out that a replay of today's call will be available from 1:30 p.m. Eastern time today until 6:00 p.m. Eastern time on November 3. The replay can be accessed by calling 888-562-0231 or 203-369-3168 and the access code at both numbers is 5549. The replay can also be accessed beginning at 2:30 p.m. eastern time today at the Investor Relations page of our website at www.lyondell.com/earnings. And reconciliations of non-GAAP financial measures to GAAP financial measures together with any other applicable disclosures, including earnings release, are currently available on our website at www.lyondell.com/earnings.

Now let's proceed to a discussion of our earnings. During the third quarter of 2006, Lyondell had net income of $57 million or $0.22 per share on a fully diluted basis, and this compares with net income of $160 million in the second quarter of 2006. The third quarter results include two significant charges and two smaller charges. The first is $176 million pretax charge related to the acquisition of the 41.25% share of the Lyondell-Citgo Refinery, which is now named the Houston Refining. Second is a $106 million pretax charge related to the impairment on the net book value of the Lake Charles ethylene facility. Results are also impacted by a $10 million charge related to mutual insurance consortium, and a $21 million charge related to financing activity. When combined, these charges reduce net income by $203 million or, $0.78 per share.

Now compared to the second quarter, the underlying third quarter earnings reflected improved performance in the ethylene and PO segments, a decline in the inorganic segment, and additionally, the quarter benefited from the increased refinery ownership, and results were also significantly stronger in the third quarter of 2005, as the ethylene, refining and inorganic segments each outperformed last year's results. The propylene oxide segment fell short of last year's performance that benefited from record MTBD margins. Lyondell's 2006 book tax rate is now estimated to be 39%, and looking forward, we believe that it will be reasonable to estimate cash taxes at an equivalent rate. Finally, our second quarter average outstanding share count was approximately 248 million shares, the corresponding share count in the diluted earnings calculation is 261 million shares.

Now let's turn our attention to our ethylene co-products and derivatives segment. As you know, the primary products of this segment are ethylene, ethylene co-products include propylene, butadiene and benzene and derivatives of ethylene which include polyethylene, ethylene oxygenate and vinyl acetate monomer or VAM. Third quarter segment EBITDA was $372 million, this compares to $279 million of EBITDA during the second quarter of 2006. An EBITDA increase primarily due to higher margins and product prices. Ethylene, ethylene derivative sales decreased by approximately 3% or 95 million pounds versus the second quarter.

Ethylene sales volumes increased, but they were more than offset by lower polyethylene sales volumes. And we attribute the polyethylene sales decline primarily to order patterns as both domestic and Asian converters postponed purchases in the declining crude price environment. Now, versus the second quarter, ethylene and ethylene derivative product prices increased by approximately $0.04 per pound as ethylene, ethylene glycol, and polyethylene prices each increased by similar amounts.

On the cost side, our average cost of ethylene production metric was relatively unchanged versus the second quarter. Increased co-product prices and decreased crude-based raw material costs combined to reduce the metric. However, this was offset by increased natural gas-based raw material costs. For example, industry consultants CMAI estimated that the cost of production for methane increased by approximately $0.035 per pound while the cost of production from naphtha declined by approximately $0.02 per pound. Acetyls results were unchanged versus the second quarter but sales volume declines were offset by increased margins.

Now during October, prices of ethylene, ethylene derivatives, and the majority of the co-products have declined in response to the decrease in crude oil prices. Butadiene and benzene have been noted exceptions to this trend. Importantly, although prices have declined, thus far margins have remained strong. Polyethylene sales volumes have increased versus the September sales pace, but not yet fully recovered to early third quarter rates. As has been our practice in response to the sales trend, we have reduced operating rates to avoid inventory build. Our ethylene plant operating rates have been in the low to mid-90 percentile range. Product prices, raw material costs, and order patterns are expected to remain quite volatile for the balance of the quarter.

Now let's turn our attention to the propylene oxide and related product segment. This segment includes propylene oxide, derivatives of propylene oxide, toluene diisocyanate, MTBE, and styrene. And during the third quarter of 2006, EBITDA for this segment was $195 million, which is a $25 million increase versus the second quarter. The propylene oxide and PO derivative products were responsible for the improved results, as both volumes and margins increased versus the prior quarter. And the majority of these products benefited from moderate sales volumes increases and we benefited further from early season aircraft deicer sales. In aggregate, increased sales prices more than offset a $0.02 per pound increase in propylene costs. And the absence of second quarter European plant turnarounds also benefited results. As styrene, fuel products and TDI results were all relatively unchanged versus the prior quarter.

And thus far in the fourth quarter, business conditions for the chemical products are relatively unchanged from the third quarter, while business conditions for the fuels products are similar to December. And as we've previously mentioned, we have the large U.S. MTBE plant down for conversion to the gasoline component iso-octene. Production should begin during early November. We also have one of our U.S. [inaudible] plants down for scheduled maintenance turnaround. The plant is scheduled to return to operation during mid-November and this maintenance is expected to impact fourth quarter results by approximately $10 million.

The next segment I'd like to review is inorganic chemicals. The primary product in this segment is titanium dioxide. In the third quarter, EBITDA was $25 million an $8 million decrease versus the second quarter. Lower sales volumes were responsible for the majority of the decline, sales decreased by approximately 9,000 tons versus the second quarter. And the decline occurred in both the U.S. and Europe. In the U.S., we attribute this to slowing housing sales and the European decline is attributing to production shortfalls, partially due to operating problems at a third party utility supplier.

Product sales prices were relatively unchanged versus the second quarter as they declined by approximately $15 per metric ton. Thus far, fourth quarter business conditions are relatively unchanged versus the third quarter. I would like to point out that the Stallingborough England plant will take some scheduled down time to make a chlorinator switch and address some of the operating issues encountered over the past six months. This is expected to improve the reliability of operations at the site.

Let me turn your focus to the refining segment. Most notable event of the quarter was the August 16th acquisition of CITGO's 41.25% ownership of the Houston refinery. This was accompanied by a new Venezuelan crude supply contract that's based on market prices versus the previous deemed margin pricing concept. The acquisition and contract change result in a few items that may create confusion when reviewing results for the past quarter, and we've attempted to address these in our earnings release and in the 8-K that we filed on August 16th. I'll use this opportunity to reiterate a couple of things.

First, you should note that transaction results and some reporting changes on Lyondell's income statement. Through August 16, Lyondell's 58.75% of refining results is recorded as income from equity investments. However, for the balance of the quarter, Lyondell's 100% ownership is reflected in the consolidated results. Additionally, you should note that within the refining segment, we recognized a $300 million charge related to the cancellation of the prior crude supply agreement. However, the nature of the transactions dictate that only $176 million of this charge or our original 58.75% interest is recognized in Lyondell's earnings and the balance in the purchase price of the refinery.

Now let's discuss performance at the refinery. The third quarter was a good quarter with record results. All major refinery units operated well throughout the quarter and crude rates averaged 270,000 barrels a day, slightly above stated capacity. Since the new supply contract was only in place for the latter two months of the quarter, comparisons to market conditions can be a little confusing. And to help remove some of the confusion, it might be worth noting that for the month of July, the difference between the previous CSA contract formula and the new formula was approximately $5 per barrel. And the contract crude volumes of 230,000 barrels a day is approximately $35 million.

As we've said before, the Maya 211 spreads have a reasonable correlation to our operations and therefore can serve can serve as a public proxy for our refinery. During the third quarter, this metric averaged $26.30 per barrel, and the spread was very strong in July, averaging more than $31 per barrel before declining to approximately $19 per barrel during September. Of course, I would remind you, this is only a proxy for our operations. Actual refinery results typically realize a percentage of this metric as they do not yield 100% conversion to gasoline and heating oil. Therefore, these numbers should be treated merely as metrics that enable us to discuss performance while providing you with visible public data so you can develop your own estimates and expectations.

Having said this, let's turn our attention to the fourth quarter. Thus far, refinery operations have been strong and industry data from plants indicates that the Maya 211 spread has averaged approximately $20 per barrel. Approximately 13 per barrel is attributed to heavy light spread and the balance to the WTI 211 spread. As an additional reference point, the WTI 211 forward curve currently averages about $8.70 per barrel for the balance of the quarter.

During the fourth quarter, there's no major maintenance activity scheduled at the refinery. However, during January the fluid cat cracker will undergo a scheduled maintenance turnaround and upgrade. The turnaround is estimated to cost approximately $50 million. Quarterly crude rates are estimated to be reduced by approximately $40 thousand per day-- barrels per day, excuse me, and the first quarter results are expected to be impacted by approximately $75 million.

That concludes the review of the business segments, I'll turn the call over to Kevin to discuss some financial factors.

Thanks, Doug. Well, today I thought I would discuss cash, recent financings, the debt reductions and the Lake Charles ethylene plant impairment. Let's start by talking about cash.

We finished the quarter with $701 million of cash on the consolidated balance sheet, Millennium had $150 million of cash and Equistar had $38 million while utilizing $90 million of its receivables facility. Based on our outlook and the strength of the cash position we decided to call the remaining 430 million balance of the 9.5% Lyondell bonds due in 2008. Prepayment premium on these bonds declines to 2.375 points on December 15th and the call is effective on that date. When this is completed we will have repaid approximately $2.5 billion since beginning our debt reduction effort late 2004. Additionally, during the third quarter, Millennium prepaid $10 million of its debt and we contributed $68 million towards our pension plans.

Regarding our recent financings, the refinery acquisition provided the opportunity for us to complete a number of actions that have been part of our long-term plan. Doug detailed the components of the financing in the earnings release, so I won't address all the specifics. Rather, I would like to review the thought process behind them.

First, we financed the transaction at the Lyondell level as a step towards consolidating our debt and simplifying our capital structure. Second, we wanted to add some long-term unsecured debt to the balance sheet and did this through issuing the eight and ten-year bonds. Third, by utilizing term loans, we have put in place some floating rate debt that is prepayable without penalty. We also wanted the financing to be efficient and we think that we accomplished this by accessing both the bank and the high-yield markets.

As a result of these actions, we've lowered the corporation's average coupon rate by approximately 80 basis points to approximately 8.8% and eliminated virtually all maturities prior to 2008. At the same time, we positioned ourselves to efficiently continue our debt reduction program over the next several years. This brings me to our updated debt reduction plans.

You probably recall that we have previously targeted a $3 billion reduction, as I mentioned the pending call will bring us to $2.5 billion. Our current thinking is that we should complete the original $3 billion and target reducing an additional $2 billion, bringing the total to $5 billion. However, I should point out there is nothing magic about this number. It simply represents the convergence of our thoughts on the outlook for chemicals and refining and our balance sheet. In summary, we believe that this is an achievable target. Most importantly, this plan will benefit all of our investors.

The final item I wanted to discuss is the Lake Charles ethylene plant impairment. We recently revisited the plant commissioning start up and operating economics and determined that we can to longer justify carrying the asset at its previous value. However, I want to make it clear that we haven't changed our views on the ethylene business cycle. Remember, that plant represents only 7% of our ethylene capacity and has not operated for the past five years. It has been continuously to be more efficient to run our other ethylene plants at increased rates than to staff and operate the Lake Charles facility.

Let me turn the call over the Dan to discuss the refinery and the inorganic's business strategy.

Thank you, Kevin. First I would like to say that we're pleased to report another good quarter both overall and at the refinery. The refinery transaction and some charges make it a little confusing, but it was a strong quarter. In fact, for the refinery, it was another record quarter as it operated above its stated crude capacity for the second consecutive quarter and financial results were at record levels before the charges.

From a market viewpoint, I'm sure that you are aware that refinery margins declined as the quarter progressed. But this was expected and it is consistent with seasonal norms. Our view of refining has not changed. To the contrary, it has been substantiated by the announcement of multi-billion refinery upgrade projects from some of the major oil companies. These 5-plus year projects are designed to add capabilities similar to those that we already have today. Operationally we've been putting together our commercial organization and contracting has proceeded well. In fact, we believe that we will realize better prices than we did under the old CITGO contract for the products.

On the supply side, we have been able to source heavy crude at good discounts and the optimization with our chemical plants is already beginning to bear fruit. For example, we will complete the conversion of the MTBE facility to iso-octene production during early November, and we expect a significant percentage of the iso-octene will be blended at our refinery. Most importantly, the refinery has been a significant cash generator, already contributing to debt reduction.

The successful acquisition of the refinery has also influenced somewhat our decision to explore our strategic alternatives with regard to the inorganics business. We have developed an internal plan that we believe will improve performance if we retain the business, but it is appropriate now to compare the internal plan to external options. We believe that the internal plan will add significantly to annual results, but we are also cognizant that it's a program that requires significant attention from our engineers and other personnel. These resources are in short supply and we need to explore whether we should concentrate that attention on the 25 billion petro-chemical and refining businesses, or more broadly to include the inorganics business. Quite frankly, since acquiring the refinery there is more competition for these resources and the inorganics business plays a smaller role within our portfolio.

Let me close this by pointing out to you that I'm convinced that both the internal and external options for this business will add significant value. Therefore, either outcome is positive. Additionally, while we intend to move the process forward as quickly and as efficiently as possible, you should understand that we have no preconceived outcome or artificial deadline.

Thank you again for your continued support and we'll now be happy to take your questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from P.J. Juvekar from Citigroup. Your line is open.

Good morning. Just a question on the refinery margins. You used to get that deemed margin, now margin is a lot more volatile. Can you just talk about what sort of volatility do you expect going forward, beside the seasonal volatility that you'll see in 4Q?

Again, PJ, I think we went through this pretty extensively when we talked about purchasing the balance of the refinery and changing the contract basis. Worldwide refining is in -- the supply demand is in a tight balance. I think it's exacerbated with the seasonal changes that you see with the very strong gasoline market in the U.S. So in the driving season portion of the year, I would expect you're going to continue to see the spiking that we've seen in the last several years because of the tight supply demand. And the shoulder seasons, like we've been in for the last several weeks, it abates somewhat and then in the winter season, depending on how severe the winter is, you can see a similar tightening based on heating oil.

I don't think you're going to see much change in that volatility pattern for the foreseeable future, because it's going to take a long time to build enough refining capacity to relieve that constraint. And that is still being built against rapidly-growing demand, both in this country but also very notably in China and [a growing sense] and India as well. So it's a worldwide situation, these are worldwide fungible products and I think you're going to see that continue -- [multiple speakers]

What I was trying to get at was there's a certain decline in September, the declining margins. That view wasn't there when the refinery was purchased. So that's what I'm talking about, the near term volatility that we have seen --

P.J., this is Doug. I guess, what we say is that that [view] was there in our minds. We have all looked back, and if you look in September and sometimes in late in the first quarter, what you see is you sit between gasoline and heating oil season. So you see that margin come down. It even did it after the hurricanes last year. It was really very typical. Maybe to help you out when you think about the forward curve, last time I looked at it, sometime ago in the winter quarters it was about an $8 curve and it was about a $12 forward curve for this WTI 211 in the summer, so you can see about $4 -- people are expecting about $4 of seasonality across the business. If you think about that and you look today, the curve is -- the 211 spread, it's about $8.50. That's where it's recovered to, so it's been kind of holding and following a trend there.

Okay, quickly on MTBE, there was decline year-over-year and last year was really strong after the hurricanes. So how much of the decline was last year being so good or is this some structural decline?

This is Doug again,P.J. If you look at the curve by month going forward, MTBE spreads were really running a little bit ahead of last year right up to mid-August when you hit that seasonal slowdown. Of course last year at mid-August, you hit a hurricane. So I think what you're seeing is, the decline is the difference between the hurricane impacts and normal seasonality.

Okay. Thank you.

Our next question comes from Jeffrey Cianci from UBS.

Thanks, guys. Just looking at refining now, you said it closed midquarter, right, but then you said two months -- I assume it was a month and a half, first clarify that?

No, it was two months. It was effective August 1st.

Okay.

It's a confusing piece, that's what Doug was trying to go through. Because of the way this is structured, for the first 15 days, it was the equity accounted for, i.e., whatever results went into the basis for the purchase --

Yes.

-- and from the 15 forward, it went through operating. I got a frown from my controller, so I'm not explaining it quite right.

Jeff, I think the key things you want to think about is the contract started on August 1, the ownership started on the 16th.

Got it. And in terms of supply, can you comment, is it all Ven crude at this point? How flexible are you with input?

About 230 of it is Ven crude, that's what we're contracted for, it's been running about 270.

What's the difference now, are you purchasing [multiple speakers] .

-- from all over the world including some other Venezuelan, but we also buy it from a lot of other sources.

Okay. And finally just a question for Kevin. The debt paydowns targets, if you include this traunch that you're doing now early, do you have a goal including this through '07? I wasn't clear the way you put it.

I think what we said, we're about $2.5 billion into the $5 billion plan. I think when we look -- when we think of the business conditions going forward here, including the refinery piece, so we see pretty good excess cash or free cash flows coming for the next couple of years. We didn't put a timetable on it, but, clearly, the cash flow is going into debt reduction free cash flow.

I was trying to get you to put a timetable on it.

I know you were. [laughter]

Would you put a timetable on a goal for a investment grade bond rating, perhaps?

That's so far out of our control, it's based on those folks that rate us, not ourselves. I would tell you that I would certainly expect, if we achieve this full $5 billion, the statistics certainly ought to be well beyond what should be required, but that's not always the only thing they look at.

Great, thanks, guys.

Edlain Rodriguez from Goldman Sachs.

Good morning.

Good morning.

Quick question on ethylene polyethylene. Can you talk about the trends you're seeing so far in October in terms of prices and volumes and how do you expect them to play out for the rest of the quarter?

Edlain, I think you're probably aware that trends are down. Certainly, as raw material and energy prices drop, our customers took advantage of the inventories they had, buying patterns shifted, and you're probably aware that ethylene did settle down in October and we have given back some of the polyethylene price increase that we got earlier in the quarter and late in the second quarter. But our view is still very optimistic going forward, we think that the fundamentals are solid. If we look at these businesses on a global basis, we don't see the same sort of trends in Europe and Asia. And we think, given a little time, things will equilibrate in a positive direction.

Okay, thank you.

Sergey Vasnetsov from Lehman Brothers.

Good morning. Just to follow-up on the Equistar question, I understand the trend is down in fourth quarter, just trying to size up the magnitude. Would you say those numbers might be comparable 4Q, and be [down numbers] might be comparable with the second quarter?

At this point in time, it's very, very difficult to call this. What you saw was a huge drop in crude price. And many people thinking that was a trend was going to continue. What you also saw is customers say, I want pressure and get as much of that price decline as I can. So you're seeing a rather significant swing. People doing all they can do to keep from buying to continue to pressure the price. At this point in time, I think it's very, very difficult to call when that turns and how long they can continue.

But if you look at what's really going on, it's well beyond anything going on in the economy. You've got to view that it's really pressure in the marketplace, and I for one don't feel comfortable saying, gee, it's going to last three more days, three more weeks, or two more months, which of course, you would have to understand in order to come to the number that you're looking for there.

I think as we go on week after week we're going to understand it better through the quarter, but suffice it to say, we've been beneficiaries as the raw material dropped more than we've been hurt by the price declines, and we would like to stay in that zone and I think the supply/demand balances should warrant that. But who knows exactly where there are price dislocations around the world at this point in time.

And the second question is timing of shutdown of Lake Charles plant. If I recall correctly, that was viewed as your option for the stronger ethylene peak. I'm just curious as far as the factors that resulted in the write-off in this particular quarter. Is it that your view on the particular cycle being behind change? Or was the decision driven or required by some outside rules such as accounting rules?

Well, it's a combination, you have to always look at what your book value of the assets are at different times, that's required. But I think we also said, if we looked at the amount of time and what it would cost to put it back in operations relative to what we're doing with the other plants and decided it was probably the best thing to do is simply leave it down, and we had to take a look at whether the level we had on the books was appropriate or not. So that's what really led to the decision.

The analysis that we did, we've been holding it as an option and, frankly, we've been expecting more of a traditional peak in the market where you would see very rapid increase and therefore a panic about supply. This cycle has been very different it's turned out to be more of a plateau. When I say a plateau, I'm taking great editorial license. It's been high one quarter, lower the next quarter, high the next quarter, it's been vacillating, but vacillating at a very solid range, and it's been doing it for several years.

It looks to me like the trend is likely to continue for the foreseeable future, the next couple of years. And unlikely that we're going to get to a point that it's going to be clear that we need that incremental capacity for multiple years, because we would have to restaff, transfer people back in, spend almost a year getting started up. So we did the analysis, went and actually inspected the equipment, see what would be required to get it started up, and the net of all that came back and said, we don't think we're going to operate that plant, so it's time to take action on it.

That makes sense. And lastly, would you have to incur some additional cash for shutting down the plant, [mediating] the site, closing down the gates, et cetera?

No, no. Right now the issue is, what do we do with the equipment, do we chop it up and sell it, do we try to get somebody else to use it for a another service. There's all those things. We don't have those plans in place. But no, there's no hidden cost of doing something else at this point in time.

Got it, thank you.

Our next question comes from Kevin McCarthy of Banc of America.

Morning, Kevin.

Good morning, good morning to you, good afternoon here on the east coast by 5 minutes. I wanted to ask you a couple things, MTBE, you mentioned you're a few weeks away from having the iso-octene capacity ready to go. If that were ready today, would you be running it or does it hold purely option value given the market prices at this juncture?

I think we would be running it, Kevin.

And what would the incremental profitability be associated with that conversion if you would indeed run it then?

I think, Kevin, as Doug may have already indicated, we think it would be pretty equivalent to where we are on MTBE today.

We've tracked it through the year, and there's not a significant difference. If anything, it might have been slightly better off through the course of year, not every day, but on balance.

The thing to bear in mind is when we bring this back up, we're making gasoline component, we're not making gasoline additive. You don't have to do anything else, it's fungible, it fits in anywhere. Whereas what's happened in the United States, we've deselected, MTBE which means that we have to export it to other regions of the world and incur transportation costs and in some case tariffs as well. From that standpoint, it's much easier to move this. When we got kind of midyear, it became apparent that was the right way to go.

We will still have some MTBE production. The source of isobutylene coming off the ethylene complexes which, I guess, will still yield us somewhere around 12 to 13,000 barrels a day. That we'll probably just continue to export, probably largely south rather than east and it's therefore cheaper on the exports. Going forward, we have the mix of iso-octene coming off of what used to be MTBE, some MTBE and a growing use of ETBE in western Europe.

Very good. Shifting gears to titanium dioxide. How would you say your '05 EBITDA generation in that business compares to a normalized level of profitability? I think of the industry as being fairly consolidated already. Do you see opportunities among the strategic players there, or would you be more likely to go to a financial buyer for a potential divestiture?

Let me take those in sequence. First of all, I hate to point out, but '05 was not representative of really what was going on in the market. '06 really isn't either. '05, if you remember, we spent a good deal of the year deinventorying what we considered excess inventory to get things in shape. Now this business is a high fixed cost business, so when you deinventory, you're underabsorbing your fixed costs and therefore you're penalizing your EBITDA.

In '06 -- I should also point out we were very successful in getting that inventory reduced right before the hurricanes, and of course, we could have reduced it easily. Was not exactly the best turn of events overall for us.

This year, we've had some significant operating problems, particularly in western Europe, so while we had the ability to sell more pounds, we didn't have the production of the pounds. So I would argue that both years have been depressed compared to what they could have, should have been, which is part of the improvement process that we're talking about. We've got to get reliability up. We've got to get the fungibility of products between the plants better than what it is now to have more flexibility in the markets.

So, I would agree with you this is a good market, it's a slow growth market, but there are relatively few players and we ought to be able to produce better results than we are, but it's going to take a fair amount of effort over a longer period of time, hence our decision to look at other alternatives. Because frankly engineering talent is scarce. And if we can put that talent to work on the bigger chunk of business, I think we're likely to yield multiples of the improvement in dollars that we could get in Ti02.

When we examine the alternatives, we open the doors to whoever is interested in the business. And I'm not particularly persuaded that strategic buyers or financial buyers, whoever wants to pay the most for it is the one that ought to be the purchaser if a purchase is done. We're simply going through that process and trying to realize maximum value. If we don't get adequate value from looking at sale alternates, then we're fully prepared to continue to improve the facilities inside. We are going to get the value one way or another.

On the polyethylene side, do you have any significant turnarounds we should be thinking about over the next couple of quarters?

No.

Then, finally for Kevin, if I can squeeze in one more brief one. Does your $5 billion new debt reduction target include some assumed level of proceeds from a Ti02 sale, or is that the target irrespective of--

[multiple speakers] -- irrespective.

Thanks, guys.

Our next question comes from Gregg Goodnight with UBS.

Good afternoon for you, too.

Thank you. Your synergies with respect to the refinery acquisition, and your channel view cracker, you've quoted in the past as saying that they would be about $50 million. Would you discuss how much of that synergy you're going to obtain with the iso-octene, how much is other, and the timing of the rest of the $50 million?

I'm not sure that iso-octene was really in the calculation that we did on the 50. That's the first thing that will be apparent from the blending capability. The 50 -- and I would tell you it's a list of many, many things that calculations to well north of 50, but they are not things that you put in place and yield dollars every day of every quarter of every year. Rather, some of those are opportunistic. We have observed many times over the past decade that there were refined products that were at times the cheapest feed stocks for the liquid crackers. But because we were fully committed on the refinery and the venture, we couldn't access those refined products.

So, indeed, if we went to the open market to buy them, it would take weeks and in some cases a couple months to get the feed stocks into the plants. By that point in time, the window of opportunity was gone. Part of this is simply being able to grab the feed stock at the right time, put it in the olefins complex some of the gasoline comes back, but you also then get cheaper ethylene feed stocks.

Some other pieces of it, go to a higher order of optimization on things like hydrogen and I think you rightly point out MTBE equivalent, but the DIB iso-octene, but looking at it differently, it's the gasoline produced as a co-product in the liquid crackers. If you're optimizing on the whole basis, there are times you might change the cracking conditions in the ethylene plants in order to yield a different pattern in the gasoline that goes back to the refineries. Similar to the DIB, but a bigger chunk, frankly.

So this is not going to be limited by execution of capital projects. There are opportunity that exist and that you will access on an opportunistic basis -- [multiple speakers]

This is not really going out and spending capital to do things. I'm sure we will find those capital projects as well. And indeed we do have in the back of our mind some, because over time we'll need to do more on the [inaudible] gasoline coming out of olefin and frankly, there's all the equipment and the refinery that will be the cheapest way to do that in all likelihood. Of course it would be very easy to do that now, it would have been more difficult to cut that deal with the Venezuelans in the middle of the process. That's future-oriented.

Second question, if I could. The butanediol in Europe, I noticed there was a large price increase proposed by producers. Would you comment on the supply demand and profitability for that product?

Butanediol has been very strong this year and not just in Europe, but really on a global basis. We're very pleased with the way that business is going.

Okay. How about quarter over quarter, how will it do versus third quarter? I mean, versus second quarter?

I think it's going to be somewhat stronger, but it's been strong all year, and year-on year, I think we've seen a significant improvement.

How about fourth quarter, get to be better?

I think when you go quarter to quarter, and you think the size of the business versus the size of other things.

It looks pretty good, looks steady and it continues to be good, Gregg.

Okay. Final question. Ethylene operating rates in 3Q, what were your operating rates light crackers and heavy crackers and blended?

Our ethylene production was about 65% heavy in Q3, Gregg.

Okay. And your operating rates versus capacity?

Well, we typically operate pretty much to hold our position, so we were operating probably around the mid-90s.

Okay. Okay. That's good enough. Thank you very much.

Jeff Zekauskas you line is open with J.P. Morgan.

Hi, good day. A few questions. In table 12, which is your cash flow statement, there is a $2.41 billion number for the purchase of the minority interests. Is that really what you wound up paying?

There's a lot of things, part of that is you have to consider that we purchased it, but of course there was also the 450 or so of debt on it at that time, of course, which 59% we were already responsible for and then you also have working capital trueups and things.

Right. So was that answer, just yes or --?

-- a million of course is also part of that that we discussed.

I don't mean to be thick about it, but when you net it out, what do you think the all-in costs of what you paid for the minority interests were?

As we said before, and as we said in the 8-K, I believe we said the purchase price was $1.9 billion and then you assume debt -- you have to remember and this is where I think you're becoming confused --

Yes, I know.

You've had unconsolidated debt that you've now assumed and are consolidating, not only do you have that, but you increased your ownership share of it.

Okay, that's perfectly clear. Second question, in terms of the October ethylene polyethylene margins, you probably had some feed stock declines and the price of benzene went up. Were margins in October very different from your margins in September?

I think they were somewhat stronger.

Yes.

But not very different.

The third question is, why don't you make any money in inorganics?

I think I touched on that, if we're not as reliable as we should be, and if we have multiple plants that theoretically can make the same products, but in actuality, don't. Then you have limited flexibility compared to what you should have. And when I talk about reliability, I'm talking about the ability to run the plants where you want to run them and make what you want to make. And clearly, second and third quarters, we had difficulties in Stallingborough, England. Some our own, some imposed by suppliers supplying utilities to us where we simply could not make the products. You couldn't make the volume, your overheads are still there and this business is almost half and half. You really take it in the ear when you have those kinds of problems.

That's a microcosm of what's gone on in the system and we've been through what I would call the identification phase and the early fixes. We do have improvements going on, they're not very evident to people, but over time, they will be. This is not something that can't be fixed, this is good, hard work that will get there over a -- call it a multiple-year time frame.

To put it in perspective for you, I think the improvement that's there just by fixing what we can see needs to be fixed is probably 50 to $100 million a year in EBITDA. It's not an insignificant number. If you come back to my comments before, if I take the similar amount of engineering talent and devote it to $25 billion of sales versus $1.2, $1.3 billion sales, I would expect the payback of that engineering talent to be greater than that $50 to $100 million. And it's our decision that we all look at alternatives, because while we know there's a prize, we know we can fix it, the cost and human talent is going to be very high and we're scarce in that human talent.

Does it take very long to figure out whether you can monetize it?

I don't know. We're early in the process, so I would not think so. But we haven't established any arbitrary deadlines because we want to make sure that we examine all the alternatives and try to produce the maximum value for what those alternatives may be.

Thank you very much.

Our next question comes from Mike Segall with Deutsche Bank Securities.

Just a follow-up on that, have you been approached regarding the Ti02 business?

By approached, has there been --

An inquirer --

I think there's been interest in the Ti02 business around the world since we've been part of it, but we're not going to comment on specifics of the transaction.

One of the questions I have, regarding $176 million contract termination cost, was that paid up front or is that amortized -- just give me the mechanics of how that was executed?

That's the charge. That's part of the whole purchase price of the transaction and this is the way the accounting works through, because of the 58.75% ownership. So that's paid and done.

Okay. So that's basically embedded in the 24.13 in the cash flow statement?

Yes.

The way you would look at it is it was a negotiated deal with Venezuela that the partnership that we own 58.75% of, agreed to pay Venezuela $300 million to terminate the previous contract and then the balance was to purchase the asset.

I had a question on Lake Charles, but you were pretty thorough about that, so I'm done there and I'm done here. Thank you.

Mike Judd with Greenwich Consultants, your line is open.

Hi, Mike.

Good morning. With your Ti02 business, would it be reasonable to assume that in order to maximize the value to shareholders that you would basically fix that and get it in shape before it would actually end up exiting the portfolio? The reason I'm asking this question is really a timing issue. I guess that would make the most sense to me, but maybe that's not reality.

Let me again tell you, I think this is not a six-week, six-month fix process. This is probably two to three years of fairly intensive engineering talent applied to do the things that we think need to be done to get this fixed. If I simply take that same amount of talent and apply it to other opportunities in the larger Lyondell, I would expect to yield a greater benefit for shareholders than the 50 to 100 million that we could generate in Ti02. If I'm right, then we would be better off provided we get decent values to probably sell. If the decent values are not available in the marketplace, we will earn it by doing the fix up. But it's a comparison that we have to make compared to alternatives.

And you can speculate any way you wish, but going through the exercise to see what kind of interest there could be and what the value could be compared to what we know the value can be by fixing it is where we'll have to come down on that. Unfortunately, you're still stuck with us making decisions of trying to generate the best value for the shareholders.

Fair enough. And I just noticed on your balance sheet, your inventory numbers were up around $450 million or about 26%. How much of that is just due to LCR being added in fully versus -- in other words, are there any build up in inventory anywhere else that's material, for instance MTBE, or somewhere along the lines?

MTBE is higher because while we're in the conversion to diisobutylene iso-octene, we're guilty of using both names, we're inventorying that material and will run it off over a longer period of time as iso-octene, so, yes, there was a build in MTBE.

But by far the biggest piece is the consolidation of the refinery. The majority of that build is the consolidation of the refinery. In fact, I would say it's 80% or so.

So is it fair to say if you look at the PO and derivatives in the fourth quarter versus the third quarter, since there was an inventory build of MTBE that there shouldn't really be much of an impact?

I don't think those are the things to be looking at in this right now. We will probably have to build some inventory, because we're taking the shutdown and we'll work that down once the unit is back up and running, and we'll see how long it takes --

You're talking about results quarter to quarter?

Oh, no, I don't think you'll see big impact on that.

All right, thanks.

You're welcome.

And we have another question, Bob Amenta, J.P. Morgan. [OPERATOR INSTRUCTIONS]

Thank you, hello. A couple questions on the refinancing from a bond holder here. Over the next couple of years, as we get into '08 and '09, Equistar and Millennium and even Lyondell with the subs have some debt coming due. What is your thought at this point regarding Equistar and Millenium, would refinance at those entities or how do you balance trying to simplify, I guess, the cap structures versus --

Part of the base case is simply that we're going to generate free cash flow over the next couple of years. We've taken care of the maturities, as you well know, we just did here at the Lyondell level, so the focus can move somewhere else as far as that's concerned. We'll start looking at how to retire the debt at Equistar. We've got some -- it's also available at Millennium. We're continuing to move forward and apply the cash and that's the highest-cost debt in most cases. So that's what we're trying to do.

The specific traunchs you talked about, if you simply go back to our target of $5 billion of debt repayment and say we're roughly at $2.5 now, the delta between those two pretty well matches all those traunchs if you add it up there.

That's a nice coincidence. The only other question I had regarding the sale of Ti02, I'm assuming if you did sell it, it would be some kind of an asset sale. The lead paint issue would not get in the way of that or are you not too concerned about that?

I don't think it's appropriate for us to get into details about this. We're going to examine the alternatives, will see what works out best all in, and we'll take that action or not take that action based on the views of value.

That's all I had. Thanks.

Frank Mitsch from BB&T Capital Markets, you line is open.

How are you?

I'm doing fine, Dan. I assume that other than anything that you would do on Ti02, there are no other portfolio moves under consideration at this particular point in time, given the digestion of refinery, is that fair to say?

I think that's fair to say.

And I heard earlier, I think Morris talked about October order patterns, or October volumes on polyethylene better than September, but not back to the level they were at the beginning of the third quarter. Can you comment on where margins are in October versus the third quarter average margins in that business?

I think I said earlier that it looks to us like margins are about in-line with where they ended the third quarter thus far in October.

Versus the third quarter average margin?

No --

Where they ended in September.

Understood. First, is the third quarter average?

You had raw material fall away in a large way. And you have customers who are backing away from the market trying to pressure the price. Thus far, we're ahead on the margins. Okay?

The $64 question is, where does this rebalance and how quickly do people have to come back to the market and what does that end up with compared to pricing. I would also remind you that nowhere is it written that raw material has to stay exactly where it is now. I would fully expect with the volatility we've seen over the past several years has not been repealed, we're going to see it again, we saw $2 of it yesterday in crude oil. This is going to be a dynamic market just as it has been, but I think where we are right now, we're in good shape thus far in the quarter, but we feel pressure from volume declines, from people not buying as long as they can work off inventory, and we see continued pressure on the pricing. We certainly have not crossed that boundary yet, but there is pressure in the marketplace and I don't think we're hiding from that at all.

Underlying all that, we have very, very good growth still going on around the world while housing has slowed down in the U.S., industrial production is actually better than it was before, so the supply demand tightness that we've seen for the past several years continues, and what I continue to hear is new additions to supply looks like they're continuing to be delayed further. So it looks to us like the strong area we've been in is likely to last going out not only next year but beyond next year.

So Dan, it sounds to me that you're convinced that the order slowdown that we're seeing right now is nothing more than a game played by customers looking at the drop in feed stocks, not at all symptomatic of a weakening marketplace and you'd anticipate that if in fact raw materials strengthen, as it looks like they will, that your volumes will come back quite nicely and perhaps you can maintain the margins that you're currently at. Is that fair?

Let me clarify a little bit. When you're in a zone like this, we, more than anybody else, can tell you exactly how much people are backing off and living off inventory and how much could be underlying supply demand actually demand. It appears to us that the factors that we usually look at for underlying demand have not been greatly impacted. There is a slowdown in housing, it's roughly offset by investor production elsewhere. But it's going to be weeks here before you can actually clarify that. People did have some inventory and they can certainly go to minimum inventories. This is typically a slower quarter. The fourth quarter is typically a slower quarter for these businesses anyway. So in many ways they may feel they are taking less risk by doing that. It's not a game. If I were in their shoes, I would be doing exactly the same thing. If we would figure out how to do that to the suppliers of crude oil, we would do exactly the same thing.

Our belief is at this point in time that the game has not changed. We still have very solid underlying supply and demand balances. That should sustain us. That does not mean we're going to hold exactly these margins going forward. They may be greater, they may be less, but thus far we've been benefited by the trend that we've seen. I would hesitate to [inaudible] for the quarter at this point in time.

Terrific, thank you.

You're welcome.

[OPERATOR INSTRUCTIONS] I'm showing no further questions.

Again, thank everybody for your attention today and we appreciate your continued interest in the Company. Look forward to talking to you next quarter.

Thank you. This does conclude the conference call. You may disconnect at this time.